Good News, Bad News, and Other News for 3D Systems

The market wasn't quite sure how to react to 3D Systems' (NYS: DDD) second-quarter earnings. Early responses resembled a minor panic, but the stock ended its earnings day essentially flat. Is this a sign that 3D Systems' rapid rise might be grinding to a halt, or is it only a speed bump on the way to better earnings in the future? Let's dig deep to find out.

What the numbers tell you3D Systems has kept its top line growing for many quarters now, but profit hasn't kept pace. That's the first takeaway from these earnings, especially when you examine the company's recent earnings history:

Sources: Morningstar and company earnings report.

Net income had a slight sequential uptick, but is lower than the year-ago quarter's bottom line. Non-GAAP earnings were $13.9 million, higher than the year-ago quarter, but under normal accounting measures profit was only $8.3 million.

Also worrisome is the decline in free cash flow that's now in its second straight quarter. This can be at least partly attributed to the ongoing 3-D printing consolidation war 3D Systems is waging with chief competitor Stratasys (NAS: SSYS) -- you can read more about their respective moves here. This quarter alone saw three notable acquisitions, as 3D Systems acquired My Robot Nation, Paramount Industries, and Bespoke Innovations. The company also bought out other shareholders in 3-D accessory printer Fresh Fiber in April to become sole owner.

3D Systems made another small acquisition earlier this week, adding Vitzu Technologies and its 2-D to 3-D image conversion technology to their consumer-focused Cubify community. The company still doesn't project this consumer segment, built around a (comparatively) low-cost Cube desktop 3-D printer, to have a real impact on sales numbers, but leadership noted strong demand for this new segment, and has promised to increase its capacity to meet that demand.

Drilling deeperThere are plenty of other interesting tidbits embedded in this report. 3D Systems sold 112% more printer units than it did in the year-ago quarter, and there's still a $12.3 million backlog to build for eager customers. The company also helpfully broke out sales by segment, and even offered a breakdown of those sales by new or existing sources:

Q2 2011

Q2 2012

Year-over-Year Change

Printer Revenue

$16.2 million

$26.1 million

61.1%

Print Material Revenue

$16.4 million

$26.2 million

59.8%

Service Revenue

$22.5 million

$31.3 million

39.1%

New Revenue (Printers)

N/A

$6.9 million

26.4%*

New Revenue (Materials)

N/A

$7.4 million

28.2%*

New Revenue (Services)

N/A

$0.5 million

1.6%*

Source: Company earnings report. * signifies percent of total segment.

Despite all of 3D Systems' growth by acquisition, it still appears that the majority of its growth is organic -- at least in these numbers. Z Corp and Vidar, the crown jewels of 3D Systems' multiyear acquisitive binge, contributed $14.4 million in revenue this quarter, or 17.2% of total revenue. These two acquisitions weren't part of reported revenues in 2011, so we can say that they've contributed fully half of all new revenue year over year.

The company's printer revenues are now firmly driven by lower-cost personal and professional printers, which made up 68% of all printer sales this quarter, compared to 32% from high-end industrial production printers.

Ideally, 3D Systems would be able to ramp up print material revenue to accommodate all the doohickeys printed from those new machines, but it hasn't reached that level. A razors-and-blades model will require the blades to drive long-term growth, so I'll be watching the revenue breakdown between printers and print materials very closely over the next few quarters.

With Europe on everyone's minds, it's also helpful to look at the geographical revenue breakdown. All reported regions grew, but as you might expect, Europe's gains were the lowest of any region:

Q2 2011

Q2 2012

Year-over-Year Change

U.S. Revenue

$28.6 million

$46.8 million

63.6%

European Revenue

$18.6 million

$24.7 million

32.8%

Asia-Pacific Revenue

$8.0 million

$12.2 million

52.5%

All Non-U.S. Revenue

$26.6 million

$36.9 million

38.7%

Source: Company earnings report.

The company's earnings call offered a bit of clarity on the European situation. When questioned about expected growth trends, CEO Abraham Reichental said that "we have not seen any discernible difference in the behavior of our customers. ...And we believe, generally, that our growth is much more linked to global and regional R&D spending trends than to any other macroeconomic or GDP performance."

I wouldn't ignore macroeconomic trends, as all but the strongest companies will have a difficult time maintaining their expenses in times of low profit and tight credit. On the other hand, spending on 3-D printing is a drop in the R&D bucket for many of 3D Systems' largest customers. Ford (NYS: F) , one of 3D Systems' major automotive clients, had nearly 15 times the R&D budget last year as 3D Systems expects in total sales this year. For many manufacturing companies, prototyping is too essential to eliminate.

Warning signs or false alarms?3D Systems isn't as highly valued as Stratasys, but there's no denying that both companies have had quite the run over the last year. A lack of present profit growth somewhat undermines the buy thesis I put forth earlier this month, but doesn't destroy it in light of the company's acquisition drive. At this point, investors will have to keep an eye out for any changes in forward guidance, which has been stable in the $330 million-$360 million range since 3D Systems' fourth-quarter earnings report at the start of the year.

Near-competitor Proto Labs (NAS: PRLB) , which makes custom molded plastic parts on demand, offered somewhat underwhelming guidance with its last earnings report, but is still less dearly valued than its 3-D printing cousins. Stratasys, slated to release its earnings on August 1, will probably be a major bellwether for the entire rapid-prototyping industry, thanks to 3D Systems' lack of major upside or downside news.